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The Risk-Return Relation in International Stock Markets


  • This paper formerly circulated under the titles “On the Out-of-Sample Stock Return Predictability: The International Evidence” and “Does Stock Market Volatility Forecast Returns: The International Evidence.” I especially thank an anonymous referee for many insightful and constructive comments. I also thank conference participants of the 2004 FMA meeting for helpful suggestion. Bill Bock and Jason Higbee provided excellent research assistance. The views expressed in this paper are those of the author and do not necessarily reflect the official positions of the Federal Reserve Bank of St. Louis or the Federal Reserve System. Morgan Stanley Capital International, Inc. (MSCI), its affiliates, and information providers make no warranties with respect to data used in this article. The MSCI data used in this article may not be used, distributed, or disseminated without the written consent of MSCI.

* Corresponding author: Research Division, Federal Reserve Bank of St. Louis, P. O. Box 442, St. Louis, MO, 63166; Phone: (314) 444-8717; E-mail:


We investigate the risk-return relation in international stock markets using realized variance constructed from MSCI (Morgan Stanley Capital International) daily stock price indices. In contrast with the capital asset pricing model, realized variance by itself provides negligible information about future excess stock market returns; however, we uncover a positive and significant risk-return tradeoff in many countries after controlling for the (U.S.) consumption-wealth ratio. U.S. realized variance is also significantly related to future international stock market returns; more importantly, it always subsumes the information content of its local counterparts. Our results indicate that stock market variance is an important determinant of the equity premium.